Multi-asset study 2023 Multi-asset Study 2023

Multi-asset study

Welcome to our second in-depth study of multi-asset funds

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Our approach

The market backdrop

Putting performance into context

What's next?

Over the past three years, markets have witnessed two extraordinary events which have resulted in a challenging environment for institutional investors and the managers that invest their assets – the COVID-19 pandemic and the unprecedented increases in gilt yields in 2022. Against this backdrop, how have multi-asset managers fared? In this study, we’ve summarised answers to these three important questions for investors:

The role of an active multi-asset fund

Above inflation returns with reduced volatility

Dynamic strategy

Diversification

Reduced governance burden

Liquidity

How have multi asset managers stood up to the turmoil of the last three years, but particularly in the last year?

Has a particular style of multi-asset fund fared better than others? How has the performance of fiduciary manager compared to asset managers?

Is there still a role for multi-asset funds and for institutional investors going forward?

Our approach to the study

Collection of data

Our analysis and conclusions are based on an independent survey of 26 multi-asset providers coordinated by Barnett Waddingham, including pooled funds offered by asset managers, and model growth portfolios offered by fiduciary managers (FM). This data goes beyond headline risk and return figures, exploring attributes such as portfolio construction, manager investment style, asset allocations and how these attributes have changed across different market environments.

We have considered how portfolio characteristics and performance vary for providers depending on their underlying style. You can view the categories we’ve chosen using the pop-outs on the right. There are a wide range of implementation approaches and investment strategies for fiduciary managers, which presented difficulties in attempting to group them into the categories shown. We have therefore considered FM portfolios as a separate category in this analysis. It should be noted that grouping the funds into mutually exclusive categories is not an objective exercise, with some mandates sharing characteristics of two or more of the above classifications. However, we have placed each fund in the category that we view as the closest fit.

Categorising the ‘style’ of portfolios

Dynamic

Diversified growth

Absolute return

Strategic

Uncertainty rules and traditional diversification breaks down

The market backdrop

Major asset class index returns over 2022

Global equity

EM equity

High yield

Corporate bonds

Fixed interest gilts

Index linked gilts

Property

Averaged of surveyed funds

0% -5% -10% -15% -20% -25% -30% -35% -40%

Quarterly volatility levels (Q1 1999 to Q4 2022)

UK corporate bonds

Gilts

Global equities (developed)

Emerging market equities

UK equities

Index linked gilts (<15Y)

120% 100% 80% 60% 40% 20% 0%

All asset classes suffered losses, in particular bonds and equity. Diversifying by investing across these asset classes did not offer protection in the way it has historically.

Most asset classes experienced heightened volatility over the year, reflecting the level of uncertainty and sensitivity amongst investors.

10th to 90th percentile

Median

31 Dec 2022

Funds that invest based on a strong conviction that markets will evolve in a specific way over longer timeframes. For example, strong conviction that markets face significant headwinds and a strong focus on downside protection should be maintained at all times.

These funds tend to use investment strategies that have minimal correlation to any one market or asset class, aiming to produce steady, incremental returns in all or most market conditions.

Invest in a wide range of assets, with an emphasis on diversification to reduce volatility rather than active changes in asset allocation.

These strategies make meaningful changes to their asset allocation to reduce volatility and drawdown, based on short-term outlooks. They should have wide asset allocation guidelines and a portfolio which is sufficiently liquid to enable that dynamism.

Have multi-asset funds demonstrated their worth amidst recent turmoil?

Putting performance into context

Understanding how multi-asset growth funds performed in 2022 will go some way to helping us answer whether these funds have a role for institutional investors going forward.

In 2022, all but one of the multi-asset managers avoided losses of the magnitudes of broad equity, bond and gilt markets, which suggests that they made use of their ability to not participate, or that their stock selection was a positive contributor. There appears to be a negative correlation between risk and return. i.e. those that took more risk suffered worse returns. Outperformance above equity and bonds also reflects the funds' ability to access other markets, including illiquid assets.

In contrast, all but two managers failed to keep up with equities over the three-year period. However, it is important to note that this was a period of significant uncertainty and equity performance defied the expectations of many market commentators.

This becomes even more true over five years – managers didn’t manage to keep pace with equities over the period, with the majority not coming close. So how much of this could be recreated by simply adjusting the allocation to equities? Have management skills and dynamism really been able to add any value?

Risk return chart for 1 year to 31 December 2022

Risk return chart for 3 years to 31 December 2022

Risk return chart for 5 years to 31 December 2022

Multi asset performance in 2022

Another way of assessing the success of managers over 2022 is by looking at the maximum drawdown experienced. That is, the worst return that could be experienced had an investor invested at a fund’s peak during the period and subsequently disinvested at its trough. It can be seen in chart to the right that none of the funds surveyed experienced a maximum drawdown of the magnitudes seen in equity and bond markets during 2022, although some came close. By these measures, it appears these funds did demonstrate their worth over a turbulent 2022 by mitigating the extent of losses experienced by broader markets, but how did they achieve this?

Max drawdown

0% -5% -10% -15% -20% -25% -30%

Fiduciary

Dynamic Allocation

Diversified Growth

Absolute Return

Strategic

Index

Risk-off approach: were funds participating in equity and other risky markets performing as expected?

We saw in the one year risk versus return chart that the better performing providers in 2022 were the less volatile ones. We also saw that over the five-year period, most multi-asset funds have not come close to keeping pace with equity returns. This led us to question whether the funds success in avoiding significant losses in 2022, and therefore their ability to outperform other major asset classes, was simply because they have not been participating in equity and other risky markets in the way that was expected.

•

During the last few years, we have witnessed periods of significant volatility across multiple asset classes, and a rapidly shifting market environment.

Dynamic asset allocation: did funds avoid losses by being dynamic with their asset allocation?

Equity allocation ranges

Credit allocation ranges

Cash allocation ranges

Equity allocation ranges

Credit allocation ranges

Cash allocation ranges

Fiduciary

Dynamic Allocation

Diversified Growth

Absolute Return

Strategic

In some cases, managers have made significant adjustments to their exposure, reflecting shifts to their market outlook during a period where we have seen heightened volatility and a shift from a low to high yield market environment. We have highlighted the strongest performers (based on three-year performance) with orange borders.

Mandates ran by fiduciary managers have on average been more dynamic over the three year period, which encapsulates both their changing market outlook as well as the changing requirements of their underlying client base.

Though themes are similar between the two groups, fiduciary managers appeared to implement larger increases to equity exposure during the recovery from COVID-19 in 2020 and 2021, and larger decreases to equity in the rate rising environment of 2022. However interestingly, this was mostly in favour of diversifying strategies and private markets for FMs compared to credit for non-FMs.

As you would expect, within the non-FM funds the dynamic asset allocation group saw the widest ranges. However, some funds within this category had a fairly stable asset allocation. Thus, the style of a fund alone is not sufficient to infer the level of flexibility you would expect to see in practice, and investors should not assume that this is the case.

Average

Diversifying strategies

The ability of these funds to allocate to alternative assets, including illiquid assets and derivatives, goes some way to explain how they protected against the losses of equities and bonds over 2022. However, this does not tell the whole story, as it was not simply the case that the funds with a higher allocation to these assets were the strongest performers. Indeed, as we discuss later in the report, funds with a stronger focus on diversification on average fared worse than others over both the one-year and three-year periods.

Very broadly, we saw managers:

• • •

Increasing exposure to safer assets such as cash and credit amidst the uncertainty surrounding the onset of the COVID-19 pandemic. Increasing exposure to equity markets, during the recovery from the pandemic. Increasing exposure to credit as the spread available became more attractive in early 2022.

However, there was significant variation from one manager to another and there was no consistent theme amongst the top-performing managers.

We also looked at the overall changes in the portfolios between early 2020 and December 2022. Whilst we saw some broad themes and set out some observations in the pop-outs to the charts, our key takeaway was that there was no correlation between managers that made significant changes to their portfolios at an asset allocation level and those that performed well. This supports the reality that the ability and willingness for a fund to be dynamic does not guarantee better returns.

Ultimately, it is likely that each of the above factors contributed in some way to multi-asset funds being able to avoid the magnitude of losses seen across other asset classes during 2022. Although, none appear to be dominant drivers of performance across the funds surveyed. In reality, a key element that is difficult to consistently capture in the data is the impact of manager skill (or ‘alpha’), which has a role to play in each of the above factors. For example, the ability for dynamic asset allocation to generate meaningful returns requires that the manager is successful at anticipating market conditions and translating those views into portfolio adjustments.

While all FM portfolios produced negative returns over 2022, the range of returns was narrower, although for both groups the range of returns over 2022 was much larger than in recent years. The non-FM group was home to both the best and the worst performers over 2022 and over three years.

Overall, the average performance of fiduciary managers in 2022 was similar to asset managers. Over the three year period, the average performance of the FM group was higher, with very few entering negative territory.

Fiduciary or asset only

One year

Three year

One year

10% 5% 0% -5% -10% -15% -20%

Traditional

Global Equities

Corporate Bonds

15% 10% 5% 0% -5% -10% -15% -20%

Absolute return funds, which aim to deliver stable positive returns across all market conditions, failed to do so during the turbulent conditions of 2022. These funds typically make use of options and derivatives to maintain a steady return, but the success of this approach is dependent on whether the views expressed by the manager come to fruition. It is worth noting that these funds have experienced mixed performance in recent years.

There was a greater range in returns for dynamic funds compared to diversified, which may illustrate that a flexible mandate can be both beneficial and detrimental to returns (i.e. ‘manager skill’ can add or detract from performance).

Diversified funds fared worse over 2022. Traditionally, the returns of equities and bonds are considered to be relatively uncorrelated, often making one a valuable diversifier of the other. However, with a sharp rise in bond yields and a resulting panic in equity markets, both asset classes were down significantly over 2022, meaning this ‘traditional diversification’ would not have provided much relief. We also observe from the chart that diversified funds experienced greater drawdowns on average than other styles, indicating the ability of diversification to mitigate downside risk was impaired during 2022.

It's important to caveat that, after dividing the non-FM funds into categories, we are left with a small sample size within each category. This is particularly true of the absolute return and strategic categories, each of which contain just two funds.

Returns by style

Corporate Bonds

Dynamic

Diversified

Absolute Return

Strategic

Global Equities

10% 5% 0% -5% -10% -15% -20%

10% 8% 6% 4% 2% 0% -2% -4% -6%

The charts above show how the best and worst performing funds in each year have performed in the subsequent year. Generally, we see that the best performing managers in one year, more often than not, do not maintain their position in the top quartile the following year. Meanwhile, 43% of managers with the worst performance in 2021 were in the top quartile for 2022. When combined with the above two charts, this indicates that there is no single approach that can consistently outperform its peers, particularly throughout periods of market stress as we have seen over the past three years. However, it is notable that three of the managers surveyed were in the top performing quartile in each of the past three years, during which we have seen vast swings in the market outlook.

Winners and losers

Top quartile performance

Bottom quartile performance

So, is there a particular style of multi-asset investing that will outperform others? Our findings, as with our previous multi-asset study carried out three years ago, suggest that this is not the case. Rather, the way in which a fund navigates a particular market is more dependent on the funds management team and their decisions, than the style of fund.

Rapidly rising gilt yields in 2022 have reduced the time horizon for many DB schemes, with many now requiring a lower investment return to meet their objectives. The result is a falling demand for return-seeking assets among DB investors; we estimate that the average allocation to return-seeking assets within our client base reduced by approximately 15% between September 2022 and March 2023 alone. As DB schemes become increasingly mature, investors must weigh up whether the merits of a multi-asset growth fund remain sufficient to warrant the costs.

For DB schemes...

Our analysis shows that many of these funds succeeded in offering investors some protection from the magnitude of losses seen across asset classes in 2022. For schemes that are materially cashflow negative but still have a significant allocation to growth, it will be valuable to access less volatile returns and avoid significant losses. Therefore, we still see a place for multi-asset growth within the DB landscape for now.

However, we have also seen that multi-asset funds failed to keep pace with equity markets over extended periods. For under funded schemes with a longer timeframe for investment, multi-asset funds may struggle to deliver the level of returns of a cheaper passive equity approach – they will be constrained by their performance objective and risk targets.

For schemes that are further along in their journeys and have a low allocation to growth (less than 10%), losses on those investments have a smaller impact on the scheme’s total asset value. We should question whether the additional time and cost of selecting and monitoring an active multi-asset mandate is justified when compared to a simple passive equity approach, particularly as schemes approaching buyout switch their attention to hedging and credit exposure. That said, in 2022 there was a 22% difference in the performance of global equities and the best performing multi-asset fund in this survey. Even if a scheme only had a 10% allocation to growth, this would still lead to a 2% difference in overall scheme performance.

For DC schemes...

The role for a multi-asset fund in the retirement phase depends on how trustees expect their members to retire, i.e. drawdown, cash or annuity. Schemes who expect their members to target an annuity will likely see little value in a multi-asset fund, with member assets instead aiming to match annuity pricing with exposure to corporate and government bonds. However, these funds provide continued access to growth while maintaining valuable downside protection - these may become increasingly important attributes as the retirement landscape and pensioner demographic evolves. However, multi-asset funds are not the only way to access downside protection when investing.

As members approach retirement and enter the ‘consolidation phase’, capital preservation becomes more concerning. The ability for multi-asset funds to soften the landing in 2022 suggests that they still have a role to play here. However, it is important for investors to assess whether their multi-asset fund is achieving what they expect. For example, an investor in this phase may opt for a combination of funds to mitigate the reliance on one manager, as we have seen through our analysis that it is the idiosyncrasies of the manager that really drive returns.

For members in the ‘growth phase’, multi-asset funds are typically less popular. Due to the longer investment timeframe at this stage (more than 10 years to retirement), members can absorb more volatility and therefore downside protection becomes less of a priority. Meanwhile, we have seen in this study that multi-asset funds have struggled to keep pace with equities over longer periods. With a priority of growth and incurring costs only where they are considered to add meaningful value for members, multi-asset funds have little role to play in comparison to passive equity funds.

Do multi-asset growth funds have a role for institutional investors going forward?

What's next?

Sarah Lochlund FIA

Partner & Senior Investment Consultant

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Chris Powell FIA CFA

Associate & Senior Investment Consultant Head of FM Research

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Hugo Gravell

Associate & Senior Investment Consultant DC Services

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Our experts

Please get in touch with your Barnett Waddingham consultant if you would like to discuss any of the topics in more detail.

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The potential to access higher returns while managing downside risk will appeal to many institutional investors. The extent to which managers have delivered on this target has been debated numerous times over the years, and is considered in this report.

The freedom for multi-asset managers to adjust their exposures to different asset classes offers the potential for managers to react to changing market conditions and outlooks.

These funds can access a broad range of asset classes which are likely to produce different returns from one another in different market environments. This allows investors to manage downside risk and reduce the chance of being fully exposed to the worst performing asset class.

Funds can provide access to the aforementioned benefits while avoiding the governance burden of selecting and monitoring multiple funds and markets. This is particularly true for smaller schemes, albeit large schemes can also struggle to access more esoteric ideas directly and tactically manage strategic asset allocations.

Multi-asset funds can provide access to less liquid assets, benefiting from the ‘illiquidity premium’, while maintaining sufficient liquidity. This was highlighted during the gilts crisis of September 2022, with many defined benefit (DB) schemes forced to drawdown from growth assets to maintain hedging exposure via their Liability Driven Investment (LDI) mandates.

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2022 was a bad year for multi-asset providers with the vast majority delivering negative returns. However, when their performance is considered versus the wider market, it does appear that most multi-asset managers were able to soften the landing and outperform both equity and bond markets. They also provided investors with some relief from the extreme volatility seen in some markets, although month-on-month performance was still twice as volatile as it was over 2021.

Over the last decade, this has been a common challenge levied against multi-asset managers as, if this was the case, then investors could have replicated performance using passive funds at a lower cost. However, a closer look made it clear that it is not that simple:

These funds have held, on average, two thirds of their portfolios in equities and bond throughout the three years to 31 December 2022. Meanwhile, the average exposure to cash was just 5% over the three-year period.

The ability for these funds to access a wide range of markets has allowed for meaningful exposures to alternatives and illiquid assets, which reduced volatility in performance and mitigated the extent of losses. However, these markets are exposed to risks and volatility of their own and do not represent a ‘risk-off’ approach. Instead, they have proven to provide effective diversification, which we discuss later in this section. For most of these funds, the reason that they have not kept pace with equities over the last five years is because that was not their true objective. Though many have historically been marketed as targeting an ‘equity-like’ return, the reality is that their objectives are often to deliver a specified margin above cash, for example cash + 4%. While this may have been in line with equity returns over longer periods, our analysis concerns a period over which cash rates were very low.

Exposure to traditional low risk assets, such as government bonds and investment grade credit, would not have protected against market volatility during the three-year period to the end of 2022.

•

In theory, this is where active multi-asset providers can add value by being dynamic and adjusting their short-term strategy to capture opportunities and manage downside risks.

While the benefit of being dynamic is difficult to measure with the data available, we can measure the extent to which managers changed their exposures to different asset classes. The charts below illustrate the degree to which managers have adjusted their exposure to various asset classes over the past three years, using the minimum, maximum and average allocations over this timeframe.

To what extent has this ability been demonstrated in practice by the multi-asset providers in this study?

Concluding comments

Having established that there was not a single dominant, visible driver of performance in 2022, we now explore if one style of multi-asset investing has proven to be better than others. Please click on the charts below to read our key learning points.

Has one style of multi-asset investing proven to be superior to others?

It is fair to say that some funds fared much worse than others over 2022; both in terms of maximum drawdown and overall calendar year performance. In fact, the range of returns over 2022 was notably wider than it has been in recent years, with the best performing fund outperforming the worst performing fund by 24%. Looking at the four years spanning 2018 to 2021, the average gap between the best and worst performing funds in the same sample was around 12%. In the next section, we explore the performance of different styles of multi-asset growth in more detail.

Below we set out some initial thoughts for institutional investors. Look out for our next briefing note on the future of multi asset investing, which will explore long-term trends affecting the multi asset marketplace and other options investors could consider. After all, truly understanding the model that is right for you needs a clear understanding of what else you could do.

Summary

Were the funds successful in managing volatility during a period of unprecedented volatility?

• • • •

We're looking to evidence:

Our study has illustrated that, broadly speaking, multi-asset funds have not been able to keep pace with equities during periods of very strong equity performance. However, they did provide some protection in an environment where both equities and bonds suffered significant losses. This was not the result of simply having a constant low participation in risky markets and there was no evidence to support the theory that the most dynamic managers were the best performers. This suggests the value added by manager’s skill varied significantly.

Our findings, along with our 2020 multi-asset study suggests there is nothing concrete to suggest FMs or traditional multi-asset managers were better able to navigate the turmoil. Over longer periods FMs performed better on average, but the breadth of returns from the asset managers was much larger, with both the best and worst performers sitting within this group. Within the asset manager group, we saw that the funds which relied on diversification struggled in 2022, in a market environment when traditional diversifiers delivered deep negative returns along with equities.

Overall, investors should ensure they are comfortable with the style of any diversified growth funds they hold. This includes being aware of when it’s likely to outperform or underperform its peers, or the reliance on manager skill risk inherent in more dynamically managed funds.

However, these funds have struggled to deliver long-term returns in line with equities. For investors with long investment timeframes who can weather volatility and avoid being forced sellers, passive equity provides an attractive and cheaper alternative.

Looking over the longer-term, as allocations to return-seeking assets shrink for DB schemes and we see continued consolidation in the DC marketplace, we may see big changes to the multi asset landscape. We will address this topic in our next multi asset briefing note. The rest of this report goes into more detail on how we reached these conclusions.

In certain circumstances, yes. We still see a role for multi-asset growth in DB schemes with higher growth allocations and DC members in the consolidation phase. Provided your advisor expects a multi-asset fund to generate the net return that is required, these funds can provide meaningful diversification and manager skill within your portfolio – many institutional investors would find it difficult to replicate what these funds have to offer without a much higher governance budget.

Crucially, across both fiduciary and asset managers, there were only three individual funds that were able to consistently perform in the top quartile from one year to the next. Our 2022 Fiduciary Manager Investment Performance Review provides a more in-depth analysis of how FMs have performance relative to total scheme assets, rather than growth portfolios in isolation.

Did they demonstrate that they were able to use their ability to adjust exposures to mitigate losses over 2022 (versus wider equity and bond markets)?

If they were successful against the above criteria, how did they manage this?

To what extent have they kept pace with equity markets over longer periods?

-21.20%

Global Equities

-23.83%

Corporate Bonds

*All references to 'Global Equities' refers to the 'FTSE All World (local) index' and all references to 'Corporate Bonds' refers to 'iBoxx Non-Gilts index' .

This briefing is aimed at and suitable for Professional Investors only.

Source: FTSE, ICE, iBoxx, MSCI

Source: FTSE, iBoxx

Source: FTSE, iBoxx, ICE, Survey participants

Source: Survey participants, FTSE, iBoxx

Source: Survey participants

Source: Survey participants, FTSE, iBoxx

Source: Survey participants

Our approach

The market backdrop

Putting performance into context

What's next?

For DC schemes, many members approaching retirement have experienced losses. It’s a significant challenge for trustees to understand what the impact will be on member’s incomes in retirement. Many trustees are asking whether more active management and the ability to protect against downside risk can provide greater certainty to members. With costs remaining an important consideration for DC schemes, the question arises as to the benefit of these funds over cheaper alternatives, such as passive equity.

Many other institutional investors have absolute return or “inflation plus” objectives. Multi asset funds have performed poorly against these overall strategic objectives in recent years. However, with most asset classes struggling during short periods of high inflation, investors may have had to rely on highly complex and potentially very risky strategies to achieve their objectives in the last few years. The challenge for these investors is whether the investment case for multi-asset funds remains going forwards.

For other institutional investors...

Institution investors with shorter investment horizons and/or specific cashflow needs may be reassured by the downside protection offered by multi-asset funds in 2022 – even if performance has disappointed compared to equity markets over longer timeframes. Reliance on manager skill does need to be considered carefully though. Indeed, some investors may opt for a combination of funds to mitigate the reliance on a single manager. Alternatively, the significant increase in yields during 2022 has increased the attractiveness of fixed income investments, particularly where investors are targeting specific cashflows and have less ambitious overall return targets.

For institutional investors with very ambitious performance objectives, recent performance calls into question the role for the types of multi-asset funds considered in this research. These investors may need to consider options in private markets and more complex strategies (such as hedge funds). However, these are long-term investments that may not be appropriate where investors have a shorter investment horizon and/or specific cashflow needs.

For DC schemes...